Question

IS-LM Model- Consider an economy in the short-run with the price level P fixed at 1 (P = 1). Now we have I = I(r), a financial sector and taxes a function of income.

C = 100 + 0.75 * (Y –T)I = 750 –20 * r

T = -40 + (1/3)Y

G = 1000;

Y = C + I + G

(M/P)d= 0.4 * Y –48 * i

M^s= 1,200(M/P)d= M^s/P

Suppose investors and bond traders expect inflation, πe= 0, so that i = r. 1.) Calculate the IS curve, i.e., solve for Y in terms of r. 2.) Calculate the LM curve. Again, solve for Y in terms of r. 3.) What are the short-run equilibrium values for Y, r, C, I. [r will not be in decimal form] 4.) Show that C + I +G = Y and that S = I. 5.) Present a properly labeled IS-LM graph showing theequilibrium level of Y and r. 6.) What is the government spending multiplierwhen G increases by 200? That is, calculate∆ Y/∆G? [NOTE, it’s not 1-/(1-MPC)] 7.) Is ∆ Y/ ∆Gfrom part (f)the same as 1-/(1-MPC+MPC(t))? If not, explain why?

Answer 1